Asian Journal- The Filipino-American Community Newspaper

TAX refunds from the federal or state income tax returns are assets of debtor. If the refund has not yet been received by debtor, the amount of refund is an account receivable, an asset of debtor’s bankruptcy estate. If the refund was received before the bankruptcy was filed and has not yet been spent, it becomes money in debtor’s possession. If it was received and spent before filing, it is no longer part of the bankruptcy estate, unless the amount was more than $600. If the amount was more than $600 and was used to pay someone at least $600 within 90 days pre-filing, the payees must be declared in the petition. In any event, it is always the better part of caution to declare the refund as an asset in schedule B of the bankruptcy petition, and to exempt the entire amount in Schedule C. Otherwise, the bankruptcy trustee may ask debtor to turn over the refund when received, or when issued by the IRS.

To illustrate, client filed his 2009 tax returns on week before he filed his Chapter 7 bankruptcy petition. Client expects a Federal tax refund of $7,000 and a State refund of $2,000, for a grand total tax refund of $9,000. Who has the right to receive the $9,000 refund? The first step is to declare the entire refund amount in schedule B of the bankruptcy petition as an account receivable. The next step is to exempt the entire amount of $9,000 in schedule C. Exemption of the entire refund is possible using CCP 703.140(b)(5), the wild card. If debtor’s equity in his residence requires using 704.730, then he is out of luck. 704 exemptions cannot accommodate accounts receivable of $9,000 in any situation. If debtor needs to use 704 to protect his residence, then he will lose the entire $9,000 to the trustee. In this is the case, debtor needs to turn over the entire $9,000 to the bankruptcy trustee when he receives it.

A different result happens when debtor has agreed to let the IRS or the State keep the refund as a deposit for future taxes owed. A debtor’s interest in a prepetition federal income tax refund was not subject to a trustee’s turnover motion because the refund had been left on deposit with the IRS where it was beyond the debtor’s reach. In re Graves, the 10th Circuit Court of Appeals held that "only the amount of any subsequent refund of 2007 taxes attributable to prepetition earnings is subject to turnover." Here, debtors filed their 2006 federal income tax return two months before they filed for Chapter 7 relief. They were entitled to $3,000 refund. Instead of having the refund sent to them, debtors opted to leave the money on deposit with the United States and apply it to their future tax liability. Pursuant to the Internal Revenue Code, such an election is irrevocable. That’s the IRS for you. Once you give them money, you cannot ever get it back in your lifetime.

The Chapter 7 trustee filed a motion for turnover of the tax refund. He argued that the refund was property of the estate. Since debtors were receiving the benefit of the refund by payment of their post-petition taxes, the trustee argued that the refund should be treated as an account receivable. The bankruptcy court denied the trustee’s motion. The 10th Circuit Bankruptcy Appellate Panel agreed with the bankruptcy court that the debtors could not be forced to turn over money that they did not have. The trustee received no greater right to the money than the debtors had when they filed for bankruptcy. Debtors had no current right to possess the refund, so the trustee had no right to seek its turnover.

The 10th Circuit agreed: "It is clear that the trustee’s interest in the application of tax refund must be limited to the same extent as the debtors’ interest-here by the strictures of 26 USC S6513(d), which makes debtors’ refund application election irrevocable."

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Lawrence Bautista Yang specializes in bankruptcy, business, real estate and civil litigation and has successfully represented more than five thousand clients in California. Please call Angie, Barbara or Jess at (626) 284-1142 for an appointment at 1000 S. Fremont Ave., Bldg. A-1 Suite 1125 Unit 58, Alhambra, CA 91803.